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Support Department Cost Allocation

Support Department Cost Allocation. Prepared by Douglas Cloud Pepperdine University. Objectives. 1. Describe the difference between support departments and producing departments. 2. Explain five reasons why support cost may be assigned to producing departments.

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Support Department Cost Allocation

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  1. Support Department Cost Allocation Prepared by Douglas Cloud Pepperdine University

  2. Objectives 1. Describe the difference between support departments and producing departments. 2. Explain five reasons why support cost may be assigned to producing departments. 3. Calculate charging rates, and distinguish between single and dual charging rates. 4. Allocate support center costs to producing departments using the direct method, the sequential method, and the reciprocal method. After studying this chapter, you should be able to: Continued

  3. Objectives 5. Calculate departmental overhead rates.

  4. Types of Departments Producing departmentsare directly responsible for creating the products or services sold to customers.

  5. Types of Departments Supporting departments provide essential support services for producing departments. Maintenance, grounds, engineering, personnel, storage

  6. Examples of Departmentalization for a Manufacturing Firm Production Departments Support Departments Assembly: Materials Storeroom: Supervisors’ salaries Clerk’s salary Small tools Depreciation on forklift Indirect materials Cafeteria: Depreciation on machinery Food Finishing: Cooks’ salaries Sandpaper Depreciation on stores Depreciation on sanders Maintenance: Janitors’ salaries Cleaning supplies Machine oil and lubricants

  7. Steps in Allocating Support Department Costs to Producing Departments 1. Departmentalize the firm. 2. Classify each department as a support department or a producing department. 3. Trace all overhead costs in the firm to a support department or producing department. 4. Allocate support department costs to the producing departments. Continued

  8. Steps in Allocating Support Department Costs to Producing Departments 5. Calculate predetermined overhead rates for producing departments. 6. Allocate overhead costs to the units of individual products through predetermined overhead rates.

  9. Examples of Cost Drivers forSupport Departments Support Department Possible Driver Accounting Number of transactions Cafeteria Number of employees Engineering Number of change orders Maintenance Machine hours; maintenance hours Payroll Number of employees Personnel Number of employees, firings, layoffs, new hires

  10. Objectives of Allocation* • To obtain a mutually agreeable price • To compute product-line profitability • To predict the economic effects of planning and control • To value inventory • To motivate managers *As identified by the IMA

  11. Hamish and Barton Fixed costs……………… $26,190 Variable costs….. $0.023 per page

  12. Variable cost: 270,000 x $0.023 $ 6,210 Fixed cost 26,190 Total cost for 270,000 pages $32,400 A Single Charge Rate • Estimated usage in pages by the three producing departments is as follows: • Audit Department 94,500 • Tax Department 67,500 • MAS Department 108,000 • Total 270,000 Hamish and Barton Average cost ($32,400 ÷ 270,000) $0.12 per page

  13. A Single Charge Rate Total Photocopying Department Charge Number of Pages Charge per Page Total Charge x = Audit Department 92,000 $0.12 $11,040 Tax Department 65,000 0.12 7,800 MAS Department 115,000 0.12 13,800 Total 272,000 $32,640

  14. Producing department capacity Total capacity Allocation ratio = Dual Charging Rate The allocation of fixed costs follow a three-step procedure: • Determination of budgeted fixed support service costs • Computation of the allocation ratio Continued

  15. Dual Charging Rate • Allocation Allocation = Allocation ratio x Budgeted fixed support service costs

  16. Dual Charging Rate Allocated Fixed Cost Original Number of Copies Budgeted Fixed Cost Percent Audit 94,500 35% $26,190 $ 9,167 Tax 67,500 25 26,190 6,548 MAS 108,00040 26,190 10,476 Total 270,000 $26,191 100%

  17. Dual Charging Rate Developing a Variable Rate Actual Number of Copies Total Charge Variable Rate Fixed Amount Variable Amount x = + = Audit 92,000 $0.023 $2,116 $ 9,167 $11,283 Tax 65,000 0.023 1,495 6,548 8,043 MAS 115,000 0.023 2,645 10,476 13,121 Total 272,000 $6,256 $26,191 $32,447

  18. The adjusted cost allocation ratios and allocated fixed cost based on the newly budgeted usage Hamish and Barton Number of Copies Allocated Fixed Cost Percent Audit 94,500 41.1 % $10,764 Tax 67,500 29.3 7,674 MAS 68,000 29,6 7,752 Total 230,000 100.0 % $26,190

  19. Choosing A Support Department Cost Allocation Method The three methods for allocating support department costs to producing departments are: • The Direct Method • The Sequential Method • The Reciprocal Method

  20. Maintenance Direct Method of Allocation Power Support Departments Grinding Assembly Producing Departments

  21. Maintenance Grinding Direct Method of Allocation Power Support Departments Assembly Producing Departments

  22. Data for Illustrating Allocation Methods Support Departments Producing Departments Direct Costs* $250,000 $160,000 $100,000 $ 60,000 Normal Activity: Kilowatt hours ----- 200,000 600,000 200,000 Maintenance hours 1,000 ----- 4,500 4,500 *For a producing department, direct costs refer only to overhead costs that are directly traceable to the department. Power Maint. Grinding Assembly

  23. 0.75 600,000 (600,000 + 200,000) Power = 200,000 (600,000 + 200,000) 4,500 (4,500 + 4,500) 0.25 4,500 (4,500 + 4,500) Maintenance = 0.50 0.50 STEP 1—CALCULATE ALLOCATION RATIOS Grinding Assembly Direct Method

  24. STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS Support Departments Producing Departments Power Maintenance Grinding Assembly Direct costs $250,000 $160,000 $100,000 $ 60,000 Power -250,000 --- 187,500 62,500 Maintenance ----160,000 80,000 80,000 $ 0 $ 0 $367,500 $202,500 a b a 0.75 x $250,000 = $187,500; 0.25 x $250,000 = $62,500 0.50 x $160,000 = $80,000 b Direct Method

  25. 2 1 3 Maintenance Grinding Assembly Sequential Method of Allocation STEP 1: Rank service departments

  26. Sequential Method of Allocation STEP 2 Power Maintenance Grinding Assembly

  27. Sequential Method of Allocation STEP 2 Maintenance Grinding Assembly

  28. 200,000 (200,000 + 600,000 + 200,000) 0.20 Power = 600,000 (200,000 + 600,000 + 200,000) 0.60 STEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding Assembly Sequential Method

  29. Mainte- nance 4,500 (4,500 + 4,500) = 0.50 4,500 (4,500 + 4,500) 0.50 STEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding Assembly Sequential Method

  30. STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS Support Departments Producing Departments Power Maintenance Grinding Assembly Direct costs $250,000 $160,000 $100,000 $ 60,000 Power -250,000 50,000 150,000 50,000 Maintenance ----210,000 105,000 105,000 $ 0 $ 0 $355,000 $215,000 a b a 0.20 x $250,000 = $50,000; 0.60 x $250,000 = $150,000; 0.20 x $250,000 = $50,000 0.50 x $210,000 = $105,000 b Sequential Method

  31. Reciprocal Method The reciprocal method of allocation recognizes all interactions among support departments.

  32. Reciprocal Method Support Departments Producing Departments Power Maintenance Grinding Assembly Direct costs: Fixed $200,000 $100,000 $ 80,000 $50,000 Variable 50,000 60,000 20,000 10,000 Total $250,000 $160,000 $100,000 $60,000 Proportion of Output Used by Departments Power Maintenance Grinding Assembly Allocation ratios: Power --- 0.20 0.60 0.20 Maintenance 0.10 --- 0.45 0.45

  33. Reciprocal Method M = Direct costs + Share of Power’s costs M = $160,000 + 0.2P (Power’s cost equation) M = $160,000 + $50,000 + 0.02M 0.98M = $210,000 M = $214,286

  34. P = Direct cost + Share of Maintenance’s cost = = $250,000 + $21,429 $271,429 P = $250,000 + 0.1M (Maintenance cost equation) P P = $250,000 + 0.1($214,286) P Reciprocal Method

  35. Reciprocal Method Allocated to Total Cost Grinding Assembly Power $271,429 $162,857 $ 54,286 Maintenance 214,286 96,429 96,429 Total $259,286 $150,715 .60 x $271,429 .20 x $271,429 .45 x $214,286 .45 x $214,286

  36. Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct Method Grinding Assembly Direct costs $100,000 $ 60,000 Allocated from Power 187,500 62,500 Allocated from Maintenance 80,000 80,000 Total cost $367,500 $202,500

  37. Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Sequential Method Grinding Assembly Direct costs $100,000 $ 60,000 Allocated from Power 150,000 50,000 Allocated from Maintenance 105,000 105,000 Total cost $355,000 $215,000

  38. Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Reciprocal Method Grinding Assembly Direct costs $100,000 $ 60,000 Allocated from Power 162,857 54,285 Allocated from Maintenance 96,429 96,429 Total cost $359,286 $210,714

  39. Departmental Overhead Rates The overhead rate for the Grinding Department is computed as follows (assuming the normal level of activity is 71,000 MH): OH rate = $355,000  71,000 = $5 per MH The overhead rate for the assembly department is computed as follows (assuming the normal level of activity is 107,500 DLH): OH rate = $215,000  107,500 = $2 per DLH

  40. End of Chapter

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